Richard Drew/AP Photo
A television screen on the floor of the New York Stock Exchange shows Federal Reserve Board Chair Jerome Powell’s Washington news conference, December 11, 2019.
No matter where; of comfort no man speak:
Let’s talk of graves, of worms, and epitaphs;
Make dust our paper and with rainy eyes
Write sorrow on the bosom of the earth.
(Richard II, Act III, Scene 2)
So it was in San Diego in early January at the annual meetings among the gathered economists, dismal professionals to a man and (occasional) woman. The New York Times on January 8 aptly summarized the concerns: high deficits and public debt, low interest rates, trade wars, and slow productivity growth. According to the Times, these warnings were echoed by economists from the World Bank, the Federal Reserve, from Washington think tanks and, of course, from Harvard.
Beneath the ominous prognoses lie two impulses. One is the natural human desire not to be embarrassed—yet again—by failing to have warned that things may go bad. The academics quoted in the Times were in several cases architects of past disasters, or at best blind and mute as disasters approached. It would not do to have the same said again, and if a disaster does not occur, few will remember the warnings. The other impulse is intellectual inertia: The economists, like France’s Bourbons, learn nothing and forget nothing; they cast their omens in terms of parables read in textbooks many decades back. To change ideas now would call into question the very foundation of their careers.
Thus we read that trade wars are bad for growth. For a country running a large deficit, the opposite is actually true: Tariffs divert demand from imports and so support domestic expansion, unless the retaliation against exports is even more extreme, which has not been the case. Economists cannot admit this because they are tied to the doctrine of comparative advantage and the virtues of free trade, textbook principles at odds with the whole history of successful industrialization and development, including in the United States.
Low interest rates are said to be a risk because some day they will end. But the Federal Reserve has been trying to raise rates—or at least talking about it—for almost a decade. Every move in that direction brings financial turmoil, here or in the wider world, and the Fed backs off. The reality, at last bleakly admitted by the president of the New York Federal Reserve Bank, is that low interest rates are locked in—in technical terms, by the shallow yield curve. That is, you can’t raise short-term rates without pushing them up above sticky long-term rates, which is perhaps the world’s most reliable recipe for credit market chaos.
But if the likely permanence of low interest rates were fully admitted, then the Congressional Budget Office would have to revise its forecasts for future interest rates, which have for many years projected that they would rise far above current levels. And lowering those forecasts would, to a large degree, make the scary projections of high future federal deficits and rising debt ratios go away. This would undercut the third pillar of the pessimistic case, already weakened by devastating criticism of its feeble theoretical foundation and flawed empirical support. And yet, amazingly, there at the meetings was Harvard’s Kenneth Rogoff yet again, preaching to a large crowd about the public debt.
The Times accurately notes that economists are coming around to the view that even under the best conditions economic growth will remain slow—a position argued at book length by yours truly five years ago, but never mind. Part of my argument in The End of Normal concerned the fourth pessimistic pillar, slow productivity growth. I argued that in our age of technological upheaval capital goods have become cheap, therefore business investment as a share of total output has declined, and so the economy relies more than ever on the strength of consumer demand, bolstered by credit cards and student and automotive debt. The evidence since then bears this out. Alas, this means that otherwise worthy calls for new spending on brick-and-mortar infrastructure and on research and development bear no relation to the supposed problem of low productivity growth.
Recessions happen not when public deficits are large and interest rates low, but when the private sector takes on more debt than it can handle and interest rates rise.
In reality, as an unquoted presentation at San Diego by modern monetary theorist Randall Wray of the Levy Economics Institute showed, recessions happen not when public deficits are large and interest rates low, but when the private sector takes on more debt than it can handle and interest rates rise. This is what happened in the late 1990s and in the mid-2000s, in the run-ups to the NASDAQ crash and the mortgage debacle. It hasn’t happened this time—yet. So far this recovery, thanks to federal spending and to tax cuts, however regressive, the overall private sector in the United States is still solvent. It is so precisely because private saving and public deficits are mirror images, and because lower import prices and surging onshore energy production have kept the trade deficit under control as the economy grew. And while household debt has grown, lower interest rates have kept the burden of that debt manageable, so far.
Does all this mean there are no downside risks? Alas not. It means only that you won’t learn about them from brand-name economists who never outgrew their textbook models. A new paper, “Into the Abyss,” by an obscure young Finn, Tuomas Malinen, should however be considered for a prizewinning doomsday scenario.
Malinen is a financial economist, which means he studies a sector that most mainstream economists pretend doesn’t exist. What he finds, in a nutshell, is over-leveraged banks and hedge funds propped up with increasing desperation by central-bank operations in the repo market—overnight repurchase agreements for Treasury bills—which is today the major source of central-bank liquidity for the financial sector. The over-leverage is the result of inveterate speculative reach-for-yield, an instance of Hyman Minsky’s rule that stability creates instability, and that safe financial practices naturally degrade into Ponzi schemes. On top of this, securitized corporate loans (CLOs) have begun to look shaky, and could lose value massively in a downturn affecting corporate profits.
Those financial losses would in turn trigger bank failures, perhaps starting with Deutsche Bank, a vast operation with, Malinen says, “it is rumored” over $30 trillion in derivatives contracts—a nominal value roughly 40 percent larger than U.S. annual GDP. A failure at DB would quickly lead to bank failures throughout Europe, in countries that lack the will or the capacity to offset the calamity with the vast increases in public spending and reduced tax burdens that would be required, alongside other emergency measures such as capital controls. He further argues that China would be unable to pick up the slack—a point I’ll dispute in a minute.
Malinen has a free-market streak, and his main scenario leans toward an Andrew Mellon–style mass liquidation, followed by recovery of the survivors. He would prefer this, for all the carnage, including physical death and destruction, to a “Green-Left fascism, suppressing both individual rights and unpopular economic activities.” Even if it were true that “Nature could be saved … but at the expense of humanity reverting to slavery and oppression.”
This seems a bit over the top. Europe may well be at extreme risk as Malinen fears; the experience of Greece in the financial crisis shows that the financial and political leadership of the European Union is ruthlessly self-protective and predatory; there is no accountability for the suffering caused or recourse for the victims. China is, however, different. The government may be authoritarian but it responds quickly—and massively—to crisis because otherwise it would not survive. Financial analysts have a bit of a blind spot with respect to China; many see that country’s banking sector through Western eyes. In reality, China’s banks are backed by the government and protected by capital controls, making them essentially inseparable from the Chinese state.
And in the next crisis, the United States may finally be moved to free itself from the deadweight of mainstream economic thought, to retire a worn-out generation of policy advisers, and to move on with the great social, economic, and environmental project known as the Green New Deal. There is a history of radical experiment and popular mobilization in this country, from which democracy emerged stronger, not weaker, than it ever was before. And for many Americans, to escape from the debt trap and from domination by bankers and billionaires into a world of work and public purpose would be the very opposite of slavery and oppression. A better word would be liberation, along with a new freedom, and a new hope.
